Inflation Changes, Yield Spreads, and Threshold Effects

Abstract: Using interest rate yield spreads to explain changes in inflation, this paper investigates whether such relationships can be modeled using two-regime threshold models. Implementing a robust test to detect evidence of a threshold, we find that the hypothesis of linearity is generally rejected. We find that the inflation-yield spread relationship at most horizons is more pronounced when the yield curve is inverted, which is usually associated with periods of tight monetary policy. This implies that monetary policy may have an asymmetric effect on inflation. © 2003 Published by Elsevier Inc. All rights reserved.